Listen to our latest “Talking Markets” podcast to hear from Michael and Drew. A transcript follows.
Host/Lee Rosenthal: Hello and welcome to Talking Markets: exclusive and unique insights from Franklin Templeton.
Ahead on this episode: breaking down important new flexibility for individuals and employers with US retirement plans, part of the massive stimulus bill passed in Washington, as a result of the coronavirus outbreak.
Here’s Michael Hadley, a partner at the Washington DC law firm Davis and Harman, and Drew Carrington, Head of Institutional Defined Contribution, at Franklin Templeton. Drew, take it away.
Drew Carrington: Great. Thanks, Mike. It’s good to be talking to you. We were originally planning on this call and this podcast we thought we would be talking about the implementation of the SECURE Act and maybe what Congress might be working on going forward with maybe SECURE 2.0, but instead we find ourselves staring at a massive bill, the CARES Act, that passed in lightning fashion in Congress as response to the COVID pandemic. I wondered if you might talk a little bit about some of the headline features of the CARES Act that affect defined contribution plans and benefit plans more generally.
Michael Hadley: The CARES Act is an acronym for the Coronavirus Aid, Relief and Economic Security and there are sort of three headlines for retirement plans and IRAs. First of all, the CARES Act provides for a new type of distribution called the coronavirus-related distribution or CRD, and if an individual is eligible for that distribution—they have to be essentially affected by the disease—they are able to take money out of a plan or IRA [Individual Retirement Account] and they get three tax advantages from it. First of all, if they’re under 59.5, they do not have to pay the 10% penalty that otherwise applies to early distributions from plans and IRAs. They can spread the income from that distribution out over three years. So a third this year, a third next year, a third the year after that, and then they are allowed to recontribute or rollover the distribution back into a plan or IRA within three years.
The second piece of relief important for retirement plans is the bill provides relief for plan loans and there’s really two types of relief [to this second piece]. First of all, for the 180-day period after enactment, that’s 180 days after March 27th, a retirement plan is allowed to increase the loan limits that otherwise apply to loans. Normally, you’re limited to taking a loan of $50,000 or 50% of your account balance and this is being increased to $100,000 or 100% of your account balance. In addition, the bill provides that if you have a loan that’s outstanding and for which there is a due date on a payment through the end of the year, through the end of 2020, you are allowed to delay payment on that plan loan for up to a year.
All the things I just talked about are similar to relief that’s been provided in prior disasters, such as hurricanes and wildfires. And all the things I just talked about in order to be eligible, you need to be affected by the coronavirus, meaning you’ve been diagnosed with it, you’ve a spouse or dependent who has been, or you’ve suffered adverse financial consequences as a result. For example, of reduced hours, being furloughed, laid off, having to stay home for childcare or owning a business that’s shut down.
The third sort of high-level headline from the CARES Act is that for 2020, individuals do not have to take a required minimum distribution. A required minimum distribution, or RMD, is a distribution that you have to start taking from your plan or IRA once you reach age 70.5, although that’s being increased to 72 going forward.
But if you are somebody who’s reached that age and would need to take an RMD in 2020 from your plan or your IRA, that’s waived, you do not have to take it. This is also available for somebody who turned 70.5 last year and had to take their first RMD by April 1 of 2020, if they didn’t take it in 2019. This RMD provision I just talked about is available to everybody. That is, you don’t have to be affected by the coronavirus. And the reason for that is that this is trying to achieve something slightly different. This is trying to solve for the problem that folks have to take their RMD based on last year’s account balance. And of course, last year’s account balance, the end of last year, the stock market was significantly higher. So Congress is providing relief for folks whose account balances have been significantly depressed.
Drew Carrington: That’s a good summary of the big three headlines. Let’s go back to those first two for a moment if we could. So for a plan to offer those features, whether it’s the new withdrawal feature or the loan aspects, do they have to make changes to the plan? Are these automatically available to everyone? How does that work?
Michael Hadley: So, as with most distribution and loan provisions, generally plan sponsors, that is employers, have a lot of flexibility in whether and the extent to which they’re going to offer them. So offering this new distribution in service is optional, as well as offering increased loan limits. That’s also an optional feature. The legislation tells plan sponsors that they don’t need to actually have a formal plan amendment to adopt some or all of what I just described. You’ll need to do a plan amendment at some point, but you have until the end of the 2022 plan year. So, a good number of years to actually do the formal amendment. That said, you need to make decisions. This is a decision that’s made by a plan sponsor in what we call the settler capacity. It’s not a fiduciary decision. So that means you need to get together the folks in the company who have the authority to decide plan amendments and then make sure that your service provider for your plan is aware of the decisions that you’d like to make. Many service providers already started to communicate with plan sponsors and looking for elections. And I would be on the lookout for that from your service provider. It can generally start, though, with simply filling out the form or otherwise communicating to your service provider to say, “Hey, I want to offer this and here’s exactly what I want to make available.”
Drew Carrington: And a plan sponsor can choose. They don’t have to adopt all of the features that are there. They could say, “Well, we’re going to adopt a loan deferral, but not the new withdrawal.” Or, “We’ll adopt the new withdrawal, but we’re going to not adopt it at the $100,000 limit, but at the $50,000 limit.” A plan sponsor can make those kinds of elections as well, right?
Michael Hadley: That’s right. The coronavirus-related distribution is up to $100,000, but for most people, I think they’re unlikely to really need that much. And probably, we want them to think twice about whether or not they empty out their retirement account just because Congress is providing some tax benefits for doing so, or at least delayed taxation.
Drew Carrington: I think the other thing that’s really interesting about it is this ability to recontribute the amounts if you take the withdrawal. I guess an observation that this is a transitory event and while people may need the cash today, they’ve given them the ability to kind of repair the damage that’s done to retirement savings if you make that withdrawal today. I think for many employers that might be a critical part of the communication. If you take one of these withdrawals, make sure you have a plan for recontributing it when things return to normal.
Michael Hadley: I agree 100%. In the past, when this has been offered in the context of major hurricanes and other disasters, that three-year repayment has tended not to be used. It’s used very sparingly. But a hurricane is very different than what we have right now. We have right now a temporary shutdown of our economy. People out of work, we hope temporarily. And that’s a little different than somebody’s house being destroyed. So I agree with you Drew 100% that we’re certainly hopeful that if folks do access their IRAs or plan balances, that they do take advantage of that repayment as quickly as they’re able to because the fact that we’ve had this coronavirus does not take away the fact that you need to have money available in retirement.
Drew Carrington: And then with respect to the eligibility question, you know, you talked about the three categories of eligibility, but the CARES Act itself actually allows for individuals to self-certify on those points, right?
Michael Hadley: That’s correct. So we’ve gotten a lot of questions from plan sponsors about, “Gee, am I really gonna have to get a copy of their test that they’re COVID-19 positive?” And the answer is no. Congress thought about this, realizing it was going to be hard physically to collect documentation and very invasive. So a plan participant, an employee can self-certify, yes, I meet one of those three criteria and actually doesn’t even have to say, which one. Self-certification is allowed and that would allow the plan to get somebody a distribution or additional loan amount as quickly as possible.
Drew Carrington: I think there are a couple of other things that were in the CARES Act that maybe weren’t at the headline level. One of them had to do with educational assistance, student loan educational assistance, a change in the rules about how that tuition assistance or student loan assistance works for the remainder of 2020. Can you tell us a little bit about that?
Michael Hadley: There are just a few other provisions that are important for HR folks that manage plans. As you said, there’s a provision that allows an employer to provide tax-free reimbursement of student loans in 2020 only for up to $5,250. The legislation builds on existing rules for what are called educational assistance programs, which can be used to pay for the kind of current tuition for somebody who’s working for you, but also taking some classes. And Congress has said, look, for 2020, we’ll allow you to do this on a tax-free basis for your employees, up to $5,250, to help them with student loan payments they may have right now. You don’t have to reimburse up to $5,250, you could do less, but it caps out at $5,250.
The CARES act also has a couple of other provisions relevant to plans. For defined benefit [DB] plans, it provides a delay in funding obligations. If your DB plan has funding obligations this year, you are allowed to delay those obligations until January 1, 2020. It’s not relief, it’s simply a delay and you would have to include interest.
And then, finally, the bill includes some additional authority to the Department of Labor to provide relief and extensions of deadlines that will apply under ERISA. So, for example, a lot of folks are asking the Department of Labor, “Hey, you know, we have a bunch of things that we normally have to send out to our employees. We’re generally doing it by paper and we can’t get things printed and hard to get the data together. And by the way, everyone’s working remotely.” So, the Department of Labor is empowered, has been asked to provide relief from some deadlines, although at least at the moment of our recording, they have not announced anything.
Drew Carrington: I know that a number of industry trade associations have requested not only regulatory relief, but regulatory clarity around a number of topics, some of which were included in CARES and some of which were not. Any particular headlines you want to call out, around that topic?
Michael Hadley: As pretty much everybody knows, there has been an extension of the deadline to file your taxes and the IRS has said that that extension to file your taxes also gives you additional time to make IRA contributions normally due by April 15, automatically extended until July 15th of this year. The extension of deadlines for filing returns may also provide relief for some plan sponsors with respect to the date for their employer contributions. And that’s not true in all cases, but in many cases, a business can wait until they file their business return to make contributions to their plan—employer contributions. There have also been some other extensions related to specific types of plans, 403(b) plans for example, which are used with educational institutions and nonprofits, were supposed to make amendments to their plan by March 31st of this year, that’s been extended to June 30th. And certain types of defined benefit plans that are so-called pre-approved—they use a pre-approved plan document—needed to adopt that by April 30th and that’s been extended to July 30th. And I think, Drew, as we move forward, we’re going to continue to see IRS and the Department of Labor provide additional relief for various deadlines that are hitting as we go along.
Now, a couple things that have not been extended. First of all, the deadline to distribute excess deferrals. So if you’ve got an employee that put too much into the plan, that deadline is still April 15th. And another deadline that I just think is really important for plan sponsors to keep in mind—when you withhold from somebody’s pay for their 401(k) contribution, the Department of Labor feels pretty strongly, you need to get that money into the plan’s trust and protected as quickly as possible. And while the Department of Labor is likely to be generous with a lot of deadlines, that’s one they feel very strongly about. So I would say to businesses, the one thing you absolutely should not do is if you’ve withheld money from somebody’s pay for their 401(k) contribution, do not use that money to fund your business. That needs to go into the plan. It needs to go in as quickly as possible. You may have some delay just to get payroll processed, but do not use it to keep the business going because the Department of Labor is not forgiving on that point.
Drew Carrington: You know, you raise an interesting question too about workers and pay. Obviously, we’re going to see a lot of, kind of new developments about the definition of an employee in places where we don’t normally see it. So union plans, union employers have historically where you’ve seen furloughs or different kinds of arrangements, but we may see a bunch of different approaches and companies that historically have not done furloughs, furloughing people, and then having to rethink sort of how do I think about, is it payroll, is it compensation? Do I do a match on it? Those kinds of questions. Could you talk a little bit about that sort of emerging category of treatment of employees in different circumstances?
Michael Hadley: Yeah, that’s a great point. And putting aside everything that Congress and the regulators have done, a lot of difficult questions about how to deal with some of the strange implications of all this. So for example, your plan says certain types of compensation you get a match on. And, employers are now making payments to folks that are not working. And as I mentioned earlier, Congress is working on new mandates on employers, one of which will require paid sick leave and paid family leave in particular circumstances and an employer is going to have to ask themselves, “Gee, is that compensation?” And as you mentioned, there are a lot of folks who are going on furlough at businesses that have not traditionally had a furlough program. And if you opened up their plan document and it says, gee, you can get your money, as a distribution, when you terminate employment, you can’t get it before then.
What is a furlough? Does that count as a termination of employment or not? A furlough traditionally means that you’re not being paid, you don’t have to go to work, but your job is there and waiting for you if and when there’s work available and traditional 401(k) defined benefit plans and the like—at least in the private sector, non-union—have never really faced that before. I’ve had a number of conversations with plan sponsors and I think the easiest answer to give is look at your plan document. And to the extent you need an amendment to sort of deal with these unusual situations, go ahead and get that done. Most importantly, obviously, is to make sure that you care for the safety of your workforce and do what you can to have a job for them, when this is all over.
Drew Carrington: Those are going to be some, I think challenging questions for plan sponsors to deal with. We’ve covered a lot of stuff here. We haven’t really talked about the RMD waiver for 2020. Maybe if we could just go back to that point for just a second. This one’s a straight-up waiver. It applies to everyone. It’s not the COVID-eligible as you alluded to for the other features. It’s unlike the DB funding relief, which is really just a delay. This is a full waiver. You don’t have to take out your required minimum distribution in 2020 and you’re not required to double up in 2021. Is that right?
Michael Hadley: That’s right. This is a total waiver. In 2021, you’ll take your RMD based on the year-end account balance at the end of this year. Let’s hope the stock market comes back, and it is as if a 2020 didn’t exist for RMD purposes. And that’s also true, by the way, if you’ve inherited an account. If you inherit an IRA or plan, you also take RMDs, exactly how you have to take them depends on the circumstances, but everybody gets a waiver for 2020.
This is available as you say, for all IRAs and all defined contribution plans. So 401(k) plans, 403(b), governmental 457s, but it is not available for defined benefit plans. So if you’re currently receiving payments from a defined benefit plan, you’ve got to continue to take them.
On this one, as I said, we do have some precedent for this. This happened once before in 2008. Congress waived the RMD for 2009. Again, the thinking being with markets down, does it really make sense to have individuals have to take money out? Shouldn’t they be preserving those savings, rather than paying tax on them? In terms of kind of what this means for plan sponsors, for employers that offer 401(k) and similar plans. One question we get a lot, is this an optional provision or one that’s mandatory? And that that’s sort of the wrong way of looking at it. It is mandatory in the sense that this requirement is waived. So there is no reason in 2020 that your 401(k) plan has to force people out. But, that being said, some employers in 2019 did offer employees the flexibility to say, “Hey, if you need the money, we’ll go ahead and keep giving it to you.” For example, if you’re on regular payments, because some folks may be using RMD as sort of degenerate income in retirement. As with all these things, we’re struggling to get up to speed on them, get them programmed at the service provider level, communicate to employees, and what we will find that we’ll have glitches, et cetera. This is one, though, that I think has generally come as sort of welcome to folks who are saying, “Gee, at least I don’t have to take the money out right now and pay tax on it.”
Drew Carrington: Going back to your point about 2009, the EBRI , the Employee Benefit Research Institute, looked at the data there and a little bit over a third of folks, opted not to take an RMD when given that option. So, I think today with the fact that this is affecting a broader swath of the population and the communication, we may see numbers even higher than that.
Well look, we’ve covered a lot of material here that’s already in the CARES Act. I know Congress is already talking about a 4.0 bill. If the CARES Act was the third pandemic responsibility, they’re already talking about a 4.0 bill. And I know there are a couple of topics, in particular, that effect benefit plans, that are part of that conversation and maybe you could give us a kind of a high-level summary on those points.
Michael Hadley: Sure. So Congress, as you say, is working on sort of the next phase called phase four or 4.0, it likely will contain some things that just couldn’t make it into phase three and it also will likely involve another fight between Republicans and Democrats, each side accusing the other of trying to include partisan ideas, taking advantage of a crisis. That said, I think there’s some things that are under active consideration. One may be to provide some relief for employers, perhaps small employers with respect to their employer contribution obligations. The scope of that exactly, what it will entail, I think, is to be determined.
Secondly, as I said, for defined benefit plans there is sort of a timeout on funding, but there’s active consideration of providing funding relief given depressed interest rates.
And thirdly, Congress knows that it must at some point solve the looming crisis in multiemployer pension plans—that’s Taft-Hartley union plans that provide defined benefit features and many of which are extremely underfunded.
Drew Carrington: The other aspect in 4.0 that’s relevant for defined contribution plan sponsors is some element of relief on Safe Harbor plans. Could you give us a little color on what the issue is there?
Michael Hadley: Sure. A Safe Harbor plan is a plan a designed generally for small employers that allows the employer to avoid non-discrimination testing. And if that’s done by the employer agreeing to make a certain level of employer contributions, either matching or profit-sharing contributions. And while current rules do allow employers some flexibility to stop those mid-year, there’s fairly limited flexibility and they’re procedural issues that are hard to meet. For example, you’ve got to get a notice out to your employees saying, “Hey, I have to stop making these contributions” and you got to do it 30 days ahead of time. Well, everybody’s home, nobody’s getting paper and many folks don’t even have a computer that they’re working with. So we know that Congress is being asked, as are the agencies, to provide relief so that folks with Safe Harbor plans can have some relief from their employer obligations.
Drew Carrington: A lot to think about for plan sponsors and their advisors. Mike, thanks as always for your time. I imagine we’re going to have a lot to talk about over the next few weeks and months. Appreciate your insight and thank you very much
Host/Lee Rosenthal: And thank you for listening to this episode of Talking Markets with Franklin Templeton. If you’d like to hear more, visit our archive of previous episodes and subscribe on iTunes, Google Play, or just about any other major podcast provider. And we hope you’ll join us next time, when we uncover more insights from our on-the-ground investment professionals.
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